What do I lose by paying interest only for 10 years on a 30-year, fixed-rate loan?

House on mortgage

Q. What do I lose by paying interest-only for 10 years on a 30-year, fixed-rate loan?

A. You'll pay thousands of dollars -- perhaps even tens of thousands of dollars -- in additional interest, miss an opportunity to build equity in your home and still owe every cent you borrowed after writing 120 checks.

If, for example, you borrowed $200,000 at 6.5%:

With a conventional loan where you paid principal and interest, your monthly payment would be $1,264 ($181 in principal for the first payment and $1,083 in interest). At the end of 10 years you would have paid $26,441 toward principal and $110,085 in interest.

If you paid only the interest, your monthly payment would be $1,083, which is only $181 less. And at the end of 10 years, you would have paid a total of $129,960 in interest -- or $19,875 more.

How can that be?

With an interest-only loan, you'd be paying interest on the full amount of the loan for 10 years. When you pay down the principal, the interest charge goes down each month as your debt is reduced.

But wait, it gets worse.

Total principal and interest payments on a conventional loan would be $136,526 -- or only $6,566 more than if you paid only the interest. That's an average out-of-pocket savings of only $656 a year.

And worse.

At the end of the 10 years, you'd still owe $200,000. If you'd paid down the principal, you'd only owe about $173,000, adding more than $26,000 in equity to your net worth.

And worse.

If you didn't sell or refinance, you'd now have to repay the full $200,000 in just 20 years. Your mortgage payments would shoot up 37% to $1,491 a month.

Of course, you could still build some equity in your home if it appreciates in value over the next decade. And we fully expect it will.

That's why we think no-interest loans are a great deal for the bank. It's the debt that just keeps on giving.

For you, not so much.

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